Cost Leadership

Chapter 4: Cost Leadership Cost leadership is one of the strategies to gain competitive advantage because it can help the firm reduce the threat of each of the five forces acting on the industry sector where the firm competes. A firm can be a cost leader by producing a product or service at a lower cost compared to its competitors for any or a combination of the following reasons: it is bigger and has more resources, it has a bigger market share, it is more experienced, it has a source of cheap raw materials, or it uses a more advanced technology. Among these sources of competitive advantage through cost leadership, the most valuable are the last three – experience, cheap inputs, and better technology -that in most cases are rare and costly and, therefore, difficult to imitate.
The company must be properly organized to fully benefit from these competitive advantages. Its lines of communication, management control systems, and compensation systems must all follow a functional or U-form structure where the CEO acts like an orchestra conductor who coordinates everyone and everything taking place within the firm. This ensures that all stages of the value chain contribute to the cost leadership strategy and that not a single employee or manager or operating process is out of line. A functional structure is hard work, but it is the best way to ensure that the company implements its strategy without hitches or with as few difficulties as possible.
A functional structure is flat, simple, and lean, allowing everyone to focus on a narrow set of high-value activities. This structure is also highly quantitative because management has to control all costs very closely. This structure also helps everyone maintain a cost leadership focus and mentality, which would be difficult if there are too many people doing too many things. It would also help that cost savings are shared with everyone in the organization as incentives.
Firms with a cost leadership strategy usually operate internationally to: (1) exploit economies of scale by targeting a larger market, (2) gain access to cheaper labor, and (3) gain access to cheaper raw materials. All these give the firm the means that it needs to control or lower its unit costs.
Chapter 5: Product Differentiation
Product differentiation is another strategy for competitive advantage where a firm succeeds in making its customers perceive that the firm’s products are more valuable than similar products sold by the firm’s competitors. Customers would buy a firm’s products because they "think" that the product’s attributes are better and they share an "emotional" connection with the firm and its products. The firm can pursue this strategy by: (1) differentiating the attributes or qualities of the product or service, (2) managing their connection with customers, and (3) showing how and why they are better and more creative than their competitors.
While a cost leadership strategy allows a firm to bring down costs, a product differentiation strategy allows the firm to raise their prices to a level that their customers are willing to pay. Using this strategy helps the firm neutralize threats and exploit opportunities by including unique product features (although these could be easily imitated) that customers want and offering a wider range of products to customers. The firm should also be more creative than its competitors in carrying out the marketing function. More difficult and costly to imitate are the way the firm and its internal processes are managed, its ability to introduce products when and where customers want them, how it manages and protects its reputation, and how well it serves customers and supports their needs.
Firms that adopt a product differentiation strategy are organized to encourage creative experimentation and risk-taking through the use of cross-functional teams and the appropriate system of managerial controls and employee compensation. While at first glance the organizational structures for pursuing cost leadership and product differentiation strategies seem contradictory, firms that learn to manage these apparent structural conflicts can succeed in pursuing both strategies and maximize the profit potential by combining the lowest cost with the highest price. Finding the appropriate transnational strategy enables a firm to pursue both strategies: responding to local markets and integrating its global operations well to neutralize threats and exploit opportunities.
Works Cited
Barney, Jay B. &amp. William B. Hesterly. Strategic Management and Competitive Advantage: Concepts and Cases. Upper Saddle River, NJ: Pearson, 2005.
Chapter 4: Cost Leadership
Chapter 5: Product Differentiation